# Bonds and Sinking funds

Question 6 (Bonds) (12 marks)

A company decides to issue 10,000 bonds with a 10-year maturity and a 6% coupon rate. The bond has a face value of $1,000 and pays semi-annual coupons. The market requires an effective yield to maturity on a bond with similar risk of 7%.

(a) What is the fair price of the bond? (6 marks)

In order to be able to pay the total face value back in 10 years, the company decides to use a sinking fund in which it will make semi-annual payments that would serve to accumulate the total face value. The sinking fund pays an interest rate of 3% compounded semi-annually.

(b) What is the semi-annual payment the company must make to the sinking fund? (4 marks)

(c) What is the total semi-annual cash outflow for the company? (2 marks)

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#### Solution Preview

Question 6 (Bonds) (12 marks)

A company decides to issue 10,000 bonds with a 10-year maturity and a 6% coupon rate. The bond has a face value of $1,000 and pays semi-annual coupons. The market requires an effective yield to maturity on a bond with similar risk of 7%.

(a) What is the fair price of the bond? (6 marks)

We need to calculate how much the bonds have been issued by using the formula as follows: -

where B is the issued price

C is the coupon ...

#### Solution Summary

This solution is comprised of a detailed explanation to answer what is the fair price of the bond, what is the semi-annual payment the company must make to the sinking fund, and what is the total semi-annual cash outflow for the company.